Allocative efficiency is achieved when the marginal
derived by the society from the last unit of every commodity produced is just
equal to its marginal cost. The marginal cost curve is represented by MC and is
upward slopping. The slopes of the two curves are a result of the law of
increasing opportunity cost. As more and more of a commodity is produced. Its
opportunity cost to society increases, hence its marginal cost increases while
its marginal benefit falls.
derived by the society from the last unit of every commodity produced is just
equal to its marginal cost. The marginal cost curve is represented by MC and is
upward slopping. The slopes of the two curves are a result of the law of
increasing opportunity cost. As more and more of a commodity is produced. Its
opportunity cost to society increases, hence its marginal cost increases while
its marginal benefit falls.
Allocative efficiency is realized at point e
where MC = MB. To the right of e, the MC of producing an extra unit of the
commodity is higher than the benefit to the society. Hence, society needs to
cut down on the production of the commodity. To the left of e, the marginal
cost of producing an extra unit of the commodity is lower than the marginal
benefit and hence society can increase its net benefit by producing more of the
commodity.
where MC = MB. To the right of e, the MC of producing an extra unit of the
commodity is higher than the benefit to the society. Hence, society needs to
cut down on the production of the commodity. To the left of e, the marginal
cost of producing an extra unit of the commodity is lower than the marginal
benefit and hence society can increase its net benefit by producing more of the
commodity.
What if the relative price of a commodity is
higher than consumers can afford? Then the demand for that good will fall,
reflecting that the society now needs less of the good and more of another
(whose demand and relative price in comparison to the first has risen). But how
would producers receive this message? Simple. The fall in demand will cause the
relative price of the commodity to fall. The fall in the relative price will
make it less profitable for the firm to continue the production of the good.
Since producers wants to get the optimal profit from the use of their resources
they will reduce the production of that good and shift their resources to the
production of any other good whose demand and relative price has risen in the
words of Adam Smith (regarded as the father of classical economics), the price
system is the invisible hand that allocates resources in a most efficient
manner.
higher than consumers can afford? Then the demand for that good will fall,
reflecting that the society now needs less of the good and more of another
(whose demand and relative price in comparison to the first has risen). But how
would producers receive this message? Simple. The fall in demand will cause the
relative price of the commodity to fall. The fall in the relative price will
make it less profitable for the firm to continue the production of the good.
Since producers wants to get the optimal profit from the use of their resources
they will reduce the production of that good and shift their resources to the
production of any other good whose demand and relative price has risen in the
words of Adam Smith (regarded as the father of classical economics), the price
system is the invisible hand that allocates resources in a most efficient
manner.
It ensures that individuals in pursing their own
selfish interest of maximizing the benefits derived from using their resources,
indirectly and unconsciously maximize the welfare of the society. If every
market in the economy is a perfectly competitive free market, the price system
will ensure that the economy achieve both “full employment and full production.
Full employment implies that all resources available to work at the rate
determined by the price system are engaged while full production imply that all
such employed resources are being used in a way that provide the maximum
benefit to society.
selfish interest of maximizing the benefits derived from using their resources,
indirectly and unconsciously maximize the welfare of the society. If every
market in the economy is a perfectly competitive free market, the price system
will ensure that the economy achieve both “full employment and full production.
Full employment implies that all resources available to work at the rate
determined by the price system are engaged while full production imply that all
such employed resources are being used in a way that provide the maximum
benefit to society.
Full production implies both productive and a locative
efficiency. Allocative efficiency means that firms are producing just the right
mix of goods and services desired by society (in our example, just the exact
combination of capital and consumption goods society desires). It implies that
society is producing at the optimal or most desired point on its production
possibilities frontier. This is achieved at the point where the marginal
benefit society derives from the last unit of each good or service produced is
just equal to its marginal cost